Fixing the Housing Mess

Go Back to the Old Design
By DEAN BAKER

A main goal of financial reform should be to promote simplicity and efficiency. In the case of housing finance, this means keeping Fannie Mae and Freddie Mac as publicly run companies.

The logic here is straightforward. Fannie Mae was created as a public company in the Depression to establish a secondary mortgage market. Before its creation, banks in various regions could often find themselves overloaded with mortgages and lacking the capital to make new loans.

By buying mortgages from banks, Fannie Mae allowed banks to issue more mortgages while limiting their exposure to risks from the housing market. Fannie Mae played a central role in supporting the postwar housing boom that hugely expanded homeownership.

The efficiency of Fannie Mae was lessened when it became a quasi-public company, alongside its newly created competitor Freddie Mac. This meant Wall Street-type salaries in the millions and tens of millions, instead of the six-figure paychecks that top-level government bureaucrats draw. It also created an incentive to take excessive risk, since the government would bear the downside from losing bets.

Fannie and Freddie got themselves into trouble in the housing bubble by first failing to recognize the bubble and second by jumping into junk mortgages near the end of the bubble. Contrary to claims of political conservatives, the decision to get into the subprime mortgages had little to do with helping moderate-income families buy homes. It was a desperate effort to recover market share from the investment banks.

Fannie and Freddie can continue to play an important role in promoting home ownership by going back to the original design. They should be boring publicly owned companies that buy and hold mortgages. Securitization in the context of a government-owned company simply adds unnecessary expense and complication. It is completely unnecessary to supply capital for mortgages, since the companies can raise it directly by selling their own stock and bonds.

If private issuers can meet the needs of a secondary market better or more efficiently than Fannie and Freddie, then they will have the opportunity to do so. But, the United States does not need a financial industry that cannot compete successfully with government bureaucrats.